Monetary Policy Report
with financial stability assessment
2 13 June
Monetary Policy Report
with financial stability assessment
2/2013
Norges Bank Oslo 2013
Address: Bankplassen 2
Postal address: Postboks 1179 Sentrum, 0107 Oslo Phone: +47 22 31 60 00
Fax: +47 22 41 31 05
E-mail: central.bank@norges-bank.no Website: http://www.norges-bank.no
Editor: Øystein Olsen Cover and design: Burson-Marsteller Printing: 07 Media
The text is set in 10½ pt Times New Roman / 9½ pt Univers
ISSN 1894-0242 (print) ISSN 1894-0250 (online)
Monetary Policy Report
with financial stability assessment
The Report is published four times a year, in March, June, September and December. The Report asses- ses the interest rate outlook and the need for countercyclical capital buffers for banks. The Report inclu- des projections of developments in the Norwegian economy.
At its meeting on 24 April 2013, the Executive Board discussed relevant themes for the Report. At the Executive Board meeting on 5 June 2013, the economic outlook, the monetary policy stance and risk in the financial system were discussed. On the basis of this discussion and a recommendation from Norges Bank’s management, the Executive Board adopted at its meeting on 19 June a monetary policy strategy for the period to the publication of the next Report on 19 September 2013. The Executive Board’s assess- ment of the economic outlook, the monetary policy strategy and the countercyclical capital buffer requi- rement is presented in “The Executive Board’s assessment”.
The Report is available on www.norges-bank.no.
Contents
The Executive Board’s assessment 7
1. Monetary policy outlook 11
The economic situation 11
The outlook ahead 13
Cross-checks of the interest rate forecast 17
Boxes:
- Criteria for an appropriate interest rate path 19
- Flexible inflation targeting 21
- Changes in the projections since Monetary Policy Report 1/13 22
2. Financial stability 24
Boxes:
- Criteria for an appropriate countercyclical capital buffer 24
- Measuring financial imbalances 30
- Household vulnerability 32
3. The projections 34
The global economy 34
Foreign exchange markets 38
Norwegian banks 39
Consumer prices 41
The Norwegian real economy 43
Annex 49
Monetary policy meetings 51
Tables and detailed projections 52
This Monetary Policy Report is based on information in the period to 13 June 2013.
The monetary policy strategy was approved by the Executive Board on 19 June 2013.
Monetary policy in Norway
Financial stability – countercyclical capital buffer
Objective
The operational target of monetary policy is low and stable inflation, with annual consumer price inflation of approximately 2.5% over time.
Implementation
Norges Bank operates a flexible inflation targeting regime, so that weight is given to both variability in inflation and variability in output and employment. In general, the direct effects on consumer prices resulting from changes in interest rates, taxes, excise duties and extraordinary temporary disturbances are not taken into account.
Monetary policy influences the economy with a lag. Norges Bank sets the interest rate with a view to stabilising inflation close to the target in the medium term. The horizon will depend on disturbances to which the economy is exposed and the effects on prospects for the path for inflation and the real economy.
The decision-making process
The monetary policy stance is presented to the Executive Board for discussion at a meeting about two weeks before the Monetary Policy Report is published. Themes of relevance to the Report have been discussed at a previous meeting.
On the basis of the analysis and discussion, the Executive Board assesses the consequences for future interest rate developments. The final decision to adopt a monetary policy strategy is made on the day before the Report is published.
The strategy applies for the period up to the next Report and is presented at the beginning of the Report.
The key policy rate is set by Norges Bank’s Executive Board. Decisions concerning the interest rate are normally taken at the Executive Board’s monetary policy meeting. The Executive Board has six monetary policy meetings per year.
Reporting
Norges Bank reports on the conduct of monetary policy in the Monetary Policy Report and the Annual Report. The Bank’s reporting obligation is set out in Article 75c of the Constitution, which stipulates that the Storting shall supervise Norway’s monetary system, and in Section 3 of the Norges Bank Act. The Annual Report is submitted to the Ministry of Finance and communicated to the King in Council and to the Storting in the Government’s Financial Market Report.
The Governor of Norges Bank provides an assessment of monetary policy in an open hearing before the Standing Committee on Finance and Economic Affairs in connection with the Storting deliberations on the Financial Market Report.
Norges Bank has been assigned primary responsibility for elaborating the decision basis for the countercyclical capital buffer. The objective of the buffer is to bolster banks’ resilience to an impending downturn and counter wide fluctuations in the supply of credit that may amplify the economic cycle. In drawing up the basis, Norges Bank will collaborate and exchange information with Finanstilsynet (Financial Supervisory Authority of Norway). The Ministry of Finance will set the buffer.
Norges Bank will recommend that the buffer should be increased when financial imbalances are building up or have built up over a period. The buffer will be assessed in the light of other requirements applying to banks. Banks would be allowed to draw on the buffer in the event of an economic downturn and large bank losses, with view to mitigating the procyclical effects of tighter bank lending.
A broad assessment of the structure and vulnerabilities of the Norwegian financial system will be published annually in the fourth quarter in a separate report.
Monetary policy
At its meeting on 13 March 2013, the Executive Board decided that the key policy rate should be in the interval 1%–2% in the period to 20 June 2013, unless the Norwegian economy was exposed to new major shocks.
In the March 2013 Monetary Policy Report, capacity utilisation was estimated to be somewhat above a normal level. Inflation remained low and there were prospects that it would take longer for inflation to pick up than projected earlier. Considerable uncertainty remained concerning developments in the international economy.
The analysis in the March Report implied a key policy rate of around 1.5% in the period to spring 2014, followed by a gradual increase towards a more normal level.
At its meeting on 24 April 2013, the Executive Board discussed themes of relevance for the June 2013 Monetary Policy Report, including analyses of banks’ response to new capital requirements.
In its discussion at the meeting on 8 May 2013, the Executive Board pointed out that the growth outlook for Europe appeared to have weakened somewhat, while global growth remained firm. The expected upward shift in key rates abroad had again been moved further out in time. Inflation in Norway had been a little lower than projected. Wage growth appeared to be lower than pro- jected this year. On the other hand, the krone had depre- ciated. The Norwegian economy appeared to be moving broadly in line with that projected. The Executive Board decided to keep the key policy rate unchanged at 1.5%.
In its discussion on 5 June and 19 June, the Executive Board placed emphasis on the following developments:
• Growth among trading partners is somewhat lower than expected. In Europe, the downturn is likely to persist longer than previously projected. In the US, growth is temporarily being dampened by tax increases and expenditure cuts, but growth prospects for the coming years are positive. Growth remains robust in emerging economies, but has been somewhat weaker than envisaged earlier. Oil prices have edged down.
• Key interest rates are close to zero in many countries.
Market key rate expectations have shown little change since the March Report.
• The krone, as measured by the import-weighted krone exchange rate index (I-44), has been 1.3% weaker so far in Q2 than projected in the March Report.
• Banks have increased interest rates on loans to house- holds and enterprises. At the same time, premiums in money and bond markets have edged down.
• Growth in the Norwegian economy has been lower than projected earlier. According to the enterprises in Norges Bank’s regional network, output prospects have weakened somewhat. Unemployment has been slightly higher than expected.
• House prices have remained broadly unchanged in recent months, but household debt is still rising at a faster pace than income.
• Consumer price inflation has been slightly higher than projected in the March Report. Underlying inflation is now estimated to range between 1¼% and 1¾%. Wage growth is projected at around 3½% in 2013, which is slightly lower than projected earlier.
The point of departure for the Executive Board’s assess- ment of monetary policy is that the key policy rate is set with a view to keeping inflation close to 2.5% over time.
The objective of low and stable inflation is weighed against the objective of stable developments in output and employment. Monetary policy also seeks to be robust and take into account the risk that financial imbalances build up and trigger or amplify an economic downturn.
The key policy rate is low because inflation is low and because interest rates abroad are very low. At the same time, there is a substantial spread between the key policy rate and the interest rates facing households and enter- prises.
The Executive Board’s assessment
The Executive Board noted that the analyses now suggest that the key policy rate will be lower than the forecast in the March Report throughout the entire projection period and that it will take longer for inflation to move up towards the inflation target.
In its discussion, the Executive Board noted that the outlook for the euro area remains highly uncertain.
Activity is falling at a slower pace and fiscal tightening appears to be on a smaller scale this year than in 2012.
The situation is nevertheless associated with considerable challenges. Unemployment is record high and is particu- larly high among youth. There is still a need for delever- aging in the private and public sector. An extensive restructuring must be carried out in euro area countries in order to boost their long-term growth potential. It will most likely take several years for production to return to the levels prevailing prior to the financial crisis.
Activity among many Norwegian export companies is being dampened by a high cost level and low external demand, particularly in European markets. Sluggish economic developments and low cost growth among trading partners may have contributed to slower wage growth in Norway, in addition to the high level of labour immigration over many years. These conditions may also have an impact on future wage settlements.
Growth appears to have slackened in several industries.
Employment has increased less than projected and unem- ployment has risen. Capacity utilisation is now assessed to be close to a normal level.
Norwegian banks are adapting to higher capital require- ments, including the impending introduction of a coun- tercyclical capital buffer. Banks have increased their lending margins and are improving their capital adequacy already ahead of the introduction of the new regulations.
Higher capital-to-loan ratios increase the robustness of banks, and may in addition contribute to restraining the rise in house prices and debt growth. The Executive Board noted that house prices are rising at a somewhat slower pace, but that growth in household debt remains higher than income growth.
In its discussion of the monetary policy situation, weight was given to the fact that inflation is low and that inflation further out is lower than projected in the March Report.
Capacity utilisation is assessed to be slightly lower than projected earlier. The Executive Board was of the view that these conditions imply a lower key policy rate ahead than projected in the March Report. At the same time, weight was given to the dampening impact of external forces on wage and price inflation. As long as the crisis in Europe persists and labour immigration remains high, a pronounced decrease in the key policy rate is likely necessary in order to bring up inflation more rapidly.
Such an interest rate response may lead to a further accel- eration in house prices and debt, augmenting the risk that financial imbalances trigger or amplify an economic downturn. This suggests a less pronounced response in interest rate setting. Against this background, the Executive Board was of the view that it is appropriate to allow more time to bring inflation up to target. At the same time, weight was given to setting the key policy rate so that there are prospects of rising inflation with a view to preventing inflation expectations from becoming entrenched at too low a level. If the Norwegian economy moves broadly in line with the projections in this Report, the Executive Board’s assessment is that the key policy rate should remain at today’s level or at a somewhat lower level in the period ahead.
At its meeting on 19 June, the Executive Board decided to keep the key policy rate unchanged at 1.5%. At the same meeting, the Executive Board decided that the key policy rate should be in the interval 1%–2% until the publication of the next Report on 19 September 2013, unless the Norwegian economy is exposed to new major shocks.
Financial stability – countercyclical capital buffer
At its meeting on 13 March, the Executive Board con- cluded that banks should build an extra capital buffer in the period ahead that they can draw on to absorb higher losses in bad times. The Executive Board also emphasised that the introduction of a countercyclical capital buffer must be viewed in the light of other requirements apply- ing to banks.
Since the March Report, the Storting (Norwegian parlia- ment) has adopted new legislation on capital requirements for banks. As from summer 2014, all banks will be subject to a minimum capital adequacy requirement of 13.5%, at least 10 percentage points of which must consist of Common Equity Tier 1 capital. An extra requirement of up to 1% in 2015 and up to 2% in 2016 will be imposed on banks classified as systemically important. The counter cyclical capital buffer will come on top of these requirements.
The basis for the Executive Board’s assessment is that banks should build a countercyclical capital buffer when financial imbalances are building up or have built up over a period. This will strengthen the resilience of the banking sector to an impending downturn and strengthen the financial system. A countercyclical capital buffer may also curb credit growth. Banks will be allowed to draw on the buffer in the event of an economic downturn and large bank losses. This may mitigate the procyclical effects of tighter bank lending.
The Executive Board emphasises that the countercyclical capital buffer is not an instrument for fine-tuning the economy. Should economic developments continue to be characterised by relatively long periods of lending growth and low losses, banks should normally hold a countercy- clical capital buffer.
In the view of the Executive Board, several years of rising house prices and lending to households have increased the risk that financial imbalances may trigger or amplify an economic downturn. Household debt is still rising
faster than income and many households may find it chal- lenging to service their debt in the event of a loss of income or higher borrowing rates. Corporate debt growth has been moderate in recent years, and total credit growth has been lower than the estimated historical trend. House price inflation has also slowed somewhat recently.
Over the coming months, the Ministry of Finance will draw up a regulation concerning the countercyclical capital buffer. When the regulation has been finalised, Norges Bank aims to issue concrete advice, on the level of the buffer and the timing of its introduction, probably in the next Report, to be published on 19 September. In the view of the Executive Board, banks in Norway are now well positioned to increase their capital ratios. Earn- ings are solid and losses are currently low. In the opinion of the Executive Board, Norwegian banks should hold a countercyclical capital buffer. The level of the buffer must be considered in the light of other capital requirements that will be gradually increased over the coming years.
Øystein Olsen 20 June 2013
The economic situation
Growth in the global economy is being supported by robust growth in emerging economies, but economic develop- ments are weak in many advanced countries. In Europe, several economies are experiencing stagnation or a fall in activity. Growth is being pulled down by fiscal tightening, deleveraging in the private sector and tight credit condi- tions. Unemployment is high and rising in many countries.
There are prospects that the economic downturn in Europe will persist somewhat longer than envisaged earlier. In the US, growth is temporarily being dampened by tax increases and expenditure cuts. Household indebtedness has decreased and the housing market is improving. Unem- ployment has declined (see Chart 1.1). In emerging econ- omies, developments have been somewhat weaker in recent months than expected earlier, but growth is still high in a number of these countries. Oil prices have edged down since March and are now around USD 105 per barrel.
Economic growth prospects abroad have weakened some- what since the March 2013 Monetary Policy Report (see Chart 1.2). Growth among trading partners is projected to pick up from 1¼% in 2013 to 2½% in 2014.1 Growth in the world economy is projected at 2½% in 2013. Considerable uncertainty remains as to developments in the international economy ahead, particularly in the euro area.
Equity prices advanced through spring, but have recently dropped slightly. Yields on long-term government securities have increased a little over the past month and are now at about the same level as in March.
Key rates are close to zero in many countries. Market expectations regarding key rates among Norway’s trad- ing partners are approximately unchanged on the March Report (see Chart 1.3). The European Central Bank (ECB) lowered its key rate from 0.75% to 0.5% in May.
Excess liquidity in the Eurosystem remains high, but is expected to decrease gradually ahead. Market partici- pants expect the short-term money rate, EONIA, to drift
1 Norges Bank’s trading partner aggregate has now been revised. Emerging economies have been given higher weights. With the new composition, annual GDP growth has been ¼ percentage point higher since 2010. See Section 3 of this Report and Staff Memo 12/2013 for further details concerning the revision.
1 Monetary policy outlook
2008 2009 2010 2011 2012 2013
0 2 4 6 8 10 12 14
0 2 4 6 8 10 12 14 Euro area
US
Chart 1.1 Unemployment rate. Percent of labour force. Seasonally adjusted.
January 2008 − May 2013
Source: Thomson Reuters
2008 2009 2010 2011 2012 2013 2014 2015 2016
−6
−5
−4
−3
−2
−1 0 1 2 3 4 5 6
−6
−5
−4
−3
−2
−1 0 1 2 3 4 5 6
MPR 1/13 MPR 2/13
Chart 1.2 GDP for trading partners in MPR 1/131) and MPR 2/13. Four−quarter change. Percent. 2008 Q1 − 2016 Q4
1) Shows what growth projections in MPR 1/13 would have been with the revised trading partner aggregate
Sources: Thomson Reuters and Norges Bank
2008 2009 2010 2011 2012 2013 2014 2015 2016 0
1 2 3 4 5 6
0 1 2 3 4 5 6
MPR 1/13 MPR 2/13
Chart 1.3 Money market rates for trading partners1) in MPR 1/13 and MPR 2/13.
Percent. 2008 Q1 − 2016 Q4
1) Broken red and blue lines show estimated forward rates for trading partners at 8 March 2013 and 13 June 2013. Forward rates are based on Overnight Index Swap (OIS) rates Source: Norges Bank
upwards from the first half of 2014. The Federal Reserve has communicated that its key rate will most likely remain close to zero up to the first half of 2015.
The krone reached historically strong levels in mid- February and has since weakened somewhat. Measured by the import-weighted krone exchange rate index (I-44), the krone has been 1.3% weaker so far in Q2 than projected in the March Report (see Chart 1.4).
Norwegian banks and mortgage companies still have ample access to wholesale funding. Funding costs have decreased over the past year. The risk premium in three- month money market rates is now around 0.30 percentage point, slightly lower than in the March Report. Risk premiums on covered bonds and bank bonds have also fallen somewhat since the March Report. At the same time, banks have raised interest rates on loans to house- holds and enterprises in response to expectations of stricter capital requirements (see Chart 1.5). Bank lending margins have thus increased.
Growth in the Norwegian economy has been somewhat lower in recent quarters than projected earlier. In May, the enterprises in Norges Bank’s regional network reported slower output growth.2 At the same time, they lowered their expectations of growth ahead. Employment growth has slowed somewhat and unemployment has been a little higher than projected. The share of enter- prises in Norges Bank’s regional network reporting capacity problems has been fairly stable recently. Capacity utilisation in the mainland economy is probably slightly lower than projected earlier and is considered to be close to a normal level (see Chart 1.6.).
Growth in the Norwegian economy is being supported by vigorous activity in the petroleum sector and construc- tion industry. At the same time, some export-oriented manufacturing segments are feeling the adverse effects of weak developments among our main trading partners and a high cost level in Norway. Both mainland exports and business investment have grown at a fairly moderate pace in recent quarters. Growth in private consumption has been slightly weaker than projected. House prices continued to rise at a fast pace through 2012, but the pace
2 For more information on regional network survey 2/2013 and the enterprises and entities contacted, see: http://www.norges-bank.no/en/about/published/
publications/regional-network-reports/regional-2/
Jan−10 Jul−10 Jan−11 Jul−11 Jan−12 Jul−12 Jan−13 80
85
90
95
100
80
85
90
95
100 I−44
Projection MPR 1/13 Chart 1.4 Import−weighted exchange rate index (I−44).1) 1 January 2010 − 13 June 2013
1) A positive slope denotes a stronger krone exchange rate Source: Norges Bank
Jan−10 Jul−10 Jan−11 Jul−11 Jan−12 Jul−12 Jan−13 0
1 2 3 4 5 6
0 1 2 3 4 5 Key policy rate 6
Difference between money market rate and key policy rate Risk premium on 5−year covered bonds
Estimated cost of mortgage financing2) Residential mortgage rate3) Projected residential mortgage rate3)
Chart 1.5 Mortgage lending rates1) and funding costs.
Percent. 1 January 2010 − 13 June 2013
1) The lending rate on lines of credit secured on dwellings provided by all banks and mortgage companies in Norway
2) Estimated using weighted interest rates on holdings of covered bonds and weighted deposit rates 3) Credit lines
Sources: DNB Markets, Statistics Norway and Norges Bank
2008 2009 2010 2011 2012 2013
−2
−1 0 1 2 3 4
−2
−1 0 1 2 3 4
MPR 1/13 MPR 2/13 Chart 1.6 Projected output gap1) in MPR 1/13 and MPR 2/13.
Percent. 2008 Q1 − 2013 Q3
1) The output gap measures the percentage deviation between GDP mainland Norway and projected potential GDP mainland Norway
Source: Norges Bank
has slowed in recent months. Household sector debt is still rising faster than income. The ratio of debt to disposable income is rising from an already high level.
At the same time, household saving is high.
Inflation has been a little higher than projected. The twelve- month rise in consumer prices (CPI) was 2.0% in May.
Consumer price inflation adjusted for tax changes and excluding energy products (CPI-ATE) was 1.4% (see Chart 1.7). Underlying inflation is projected at between 1¼% and 1¾%. Wage growth is likely to be around 3½% in 2013.
The outlook ahead
The operational target of monetary policy is low and stable inflation, with annual consumer price inflation of close to 2.5% over time. Over the past 10 years, average inflation has been somewhat below, but close to, 2.5%
(see Chart 1.8). Inflation expectations remain close to the inflation target (see Chart 1.9).
The key policy rate is 1.5%. The key policy rate is low because inflation is low and because interest rates abroad are very low. At the same time, there is a considerable spread between the key policy rate and the interest rates facing households and enterprises.
The situation in the Norwegian economy differs from that of other advanced economies. In Norway, growth has been supported in large part by high oil prices and strong demand from the petroleum industry, in conjunction with a low key policy rate. Capacity utilisation in the mainland economy has risen gradually since the financial crisis. There are now signs of slowing growth in the Norwegian economy. Employment growth has slackened and Norges Bank’s regional network contacts have become slightly less optimistic. Capacity utilisation is projected to remain close to a normal level ahead.
Despite robust growth in the Norwegian economy, inflation has been low for a long time. Cost inflation in sectors supplying goods and services to households has been moderate in recent years. This has held down price inflation for domestically produced goods and services (see Chart 1.10). Weak external price impulses and the appreciation of the krone have led to a fall in prices for imported consumer goods.
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
−2.5 0 2.5 5 7.5
−2.5 0 2.5 5 7.5
CPI 20% trimmed mean
CPI−ATE1) CPIXE2)
CPIM3)
Chart 1.7 Consumer prices. 12−month change.
Percent. January 2004 − May 2013
1) CPI adjusted for tax changes and excluding energy products 2) CPI adjusted for tax changes and excluding temporary changes in energy prices. Real time figures. See Norges Bank Staff Memo 7/2008 and 3/2009. From June 2013, the method for calculating CPIXE will be changed. For more information see www.norges−bank.no 3) Model−based indicator of underlying inflation. See Norges Bank Economic Commentaries 5/2010 Sources: Statistics Norway and Norges Bank
1981 1986 1991 1996 2001 2006 2011
0 2 4 6 8 10 12 14
0 2 4 6 8 10 12 14
Variation Inflation target CPI Chart 1.8 Inflation. 10−year moving average1) and variation2) in CPI.
Percent. 1981 − 2012
1) The moving average is calculated 10 years back 2) The band around the CPI is the variation in the CPI adjusted for tax changes and excluding energy products in the average period, measured by +/− one standard deviation Sources: Statistics Norway and Norges Bank
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 0
2.5 5
0 2.5 5
Expected inflation 5 years ahead Expected inflation 2 years ahead Chart 1.9 Expected consumer price inflation 2 and 5 years ahead.1) Percent. 2004 Q1 − 2013 Q2
1) Average of expectations of employer/employee organisations and economists in the financial industry and academia
Sources: TNS Gallup and Opinion Perduco
Wage growth in 2013 is likely to be lower than projected in the March Report. Sluggish economic growth and low cost inflation among our trading partners have probably contributed to curbing wage growth in Norway. In addi- tion, high labour immigration over several years may also have dampened wage growth. These conditions may also have an impact on wage growth ahead. The rise in prices for imported consumer goods is expected to remain low owing to continued low external price impulses. There are prospects that it will take even longer than previously projected for inflation to pick up.
2008 2009 2010 2011 2012 2013 2014 2015 2016 0
1 2 3 4 5 6 7
0 1 2 3 4 5 6 7 30% 50% 70% 90%
Chart 1.11a Projected key policy rate in the baseline scenario with probability distribution. Percent. 2008 Q1 − 2016 Q4
Source: Norges Bank
2008 2009 2010 2011 2012 2013 2014 2015 2016
−4
−3
−2
−1 0 1 2 3 4 5
−4
−3
−2
−1 0 1 2 3 4 5 30% 50% 70% 90%
Chart 1.11b Projected output gap1) in the baseline scenario with probability distribution. Percent. 2008 Q1 − 2016 Q4
1) The output gap measures the percentage deviation between mainland GDP and projected potential mainland GDP
Source: Norges Bank
2008 2009 2010 2011 2012 2013 2014 2015 2016
−1 0 1 2 3 4 5
−1 0 1 2 3 4 5
30% 50% 70% 90%
Chart 1.11c Projected CPI in the baseline scenario with probability distribution. Four−quarter change. Percent. 2008 Q1 − 2016 Q4
Sources: Statistics Norway and Norges Bank
2008 2009 2010 2011 2012 2013 2014 2015 2016
−1 0 1 2 3 4 5
−1 0 1 2 3 4 5
30% 50% 70% 90%
Chart 1.11d Projected CPI−ATE1) in the baseline scenario with probability distribution. Four−quarter change. Percent. 2008 Q1 − 2016 Q4
1) CPI adjusted for tax changes and excluding energy products.
Sources: Statistics Norway and Norges Bank
2008 2009 2010 2011 2012 2013
−2
−1 0 1 2 3 4 5 6
−2
−1 0 1 2 3 4 5 CPI−ATE 6
Domestically produced goods and services excluding house rent Imported consumer goods
House rent Chart 1.10 CPI−ATE1) by supplier sector.
Four−quarter change. Percent. 2008 Q1 − 2013 Q1
1) CPI adjusted for tax changes and excluding energy products Sources: Statistics Norway and Norges Bank
The key policy rate is set with a view to stabilising infla- tion at the inflation target without triggering excessive fluctuations in output and employment. Monetary policy in Norway should also be robust and mitigate the risk that financial imbalances build up and trigger or amplify a downturn in the economy (see box on the criteria for an appropriate interest rate path on pages 20 and 21 and box on flexible inflation targeting on page 19).
Since the March Report, inflation has been slightly higher than projected and the krone has depreciated. On the other hand, wage growth is likely to be lower than projected earlier and capacity utilisation is projected to be slightly lower than previously envisaged. Growth among our trading partners has been revised down further. In addition, the spread between bank lending rates and the key policy rate has widened a little and the spread is expected to remain wider ahead than previously projected. On balance, new information since the March Report suggests a lower forecast for the key policy rate.
It is primarily external factors that are holding down price and cost inflation in the Norwegian economy. As long as external economic developments remain sluggish and labour immigration remains high, wage growth and inflation in Norway are likely to remain dampened.
In such a situation, a pronounced decrease in the key policy rate is likely necessary in order to bring inflation more quickly up towards target. At the same time, such a change in the interest rate may amplify house price inflation and debt growth, which are already at high levels.
This may increase the risk that financial imbalances trigger or amplify an economic downturn. This suggests a less pronounced response to the low outlook for infla- tion and using a longer period for bringing up inflation.
The analyses in this Report imply a key policy rate at the current level, or somewhat lower, in the year ahead (see Charts 1.11 a-d and Chart 1.12). The rate is projected to rise gradually from the end of next year. Along this path, the key policy rate is lower than projected in the March Report throughout the entire projection period (see box on page 22).
This projection for the key policy rate entails prospects of a gradual rise in inflation and results in capacity utili- sation that is close to a normal level through the projection period (see Chart 1.13).
3/07 1/082/08
3/08
17 Dec 08
1/092/09
3/091/102/10 3/101/11 2/11
3/11
1/12 2/12 3/12
1/13 2/13
2008 2010 2012 2014 2016
0 1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8 MPR 3/12
MPR 1/13 MPR 2/13 Chart 1.12 Interval for the key policy rate at the end of each strategy period, actual developments and projected key policy rate in the baseline scenario.
Percent. 1 January 2008 − 31 December 2016
Source: Norges Bank
2008 2009 2010 2011 2012 2013 2014 2015 2016
−4
−3
−2
−1 0 1 2 3 4
−1 0 1 2 3 4 5 6
Output gap (left−hand scale) CPI−ATE (right−hand scale) Chart 1.13 Projected inflation1) and output gap in the baseline scenario.
Percent. 2008 Q1 − 2016 Q4
1) CPI−ATE: CPI adjusted for tax changes and excluding energy products Sources: Statistics Norway and Norges Bank
2004 2006 2008 2010 2012 2014 2016
−15
−10
−5 0 5 10 15 20 25
−15
−10
−5 0 5 10 15 20 25 House prices
Credit growth Chart 1.14 Household credit growth1) and house prices.
Four−quarter change. Percent. 2004 Q1 − 2016 Q4
1) From 1 January 2012 the Norwegian standard for institutional sector grouping was changed. For credit growth this implies a break in the series from March 2012
Sources: Statistics Norway, the real estate sector (NEF, EFF, Finn.no and ECON Pöyry) and Norges Bank
The rise in house prices is projected to slow and is expected to be lower than growth in household disposable income in the coming years (see Chart 1.14). On the other hand, there are prospects of a continued rise in household debt ratios (see Chart 1.15).
Money market rates are projected to track developments in the key policy rate (see Chart 1.16). Bank lending rates are expected to track developments in money market rates in the short term, but may rise somewhat less further out in the projection period (see Chart 1.17). The interest rate differential against other countries is expected to narrow somewhat in the short term, and then gradually widen. The result may be that the krone remains strong (see Chart 1.18).
Mainland GDP is projected to grow by around 2¾%
annually between 2014 and 2016.. Unemployment is expected to remain at today’s level. Wage growth is projected at 3¾% in 2014 and 4¼% in 2015 and 2016.
Activity levels are still expected to remain high in oil- related sectors. At the same time, sluggish growth among trading partners and further weakening of Norway’s competitiveness will weigh on growth in other export sectors. Mainland business investment is expected to grow more slowly in the years ahead than has been observed in the past few years. At the same time, high population growth will also sustain housing investment at a high level. Growth in private consumption is projected at around 3% annually through the projection period. The saving ratio is expected to rise somewhat, but is projected to be lower than in the March Report.
The projections for the key policy rate, inflation, capacity utilisation and other variables are based on Norges Bank’s assessment of the economic situation and perception of the functioning of the economy and monetary policy.
If economic developments are broadly in line with projections, economic agents can expect the interest rate path to be approximately as projected. Monetary policy may respond to changes in the economic outlook, or if the relationships between the interest rate, inflation, out- put and employment differ from those assumed.
There is uncertainty about future interest rate develop- ments. The uncertainty surrounding Norges Bank’s projections is illustrated using fan charts (see Charts 1.11 a-d). The width of the fan reflects historical uncertainty.
1988 1992 1996 2000 2004 2008 2012 2016
0 2 4 6 8 10 12
0 50 100 150 200 250
Interest burden (left−hand scale) Debt ratio (right−hand scale) Chart 1.15 Household debt ratio1) and interest burden.2)
Percent. 1988 Q1 − 2016 Q4
1) Loan debt as a percentage of disposable income adjusted for estimated reinvested dividend income for 2000 – 2005 and redemption/reduction of equity capital for 2006 – 2012 Q3 2) Interest expenses after tax as a percentage of disposable income adjusted for estimated reinvested dividend income for 2000 – 2005 and redemption/reduction of equity capital for 2006 – 2016 plus interest expenses
Sources: Statistics Norway and Norges Bank
2008 2009 2010 2011 2012 2013 2014 2015 2016 0
1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8 Estimated forward rates MPR 1/13
Estimated forward rates MPR 2/13
Money market rate in the baseline scenario MPR 1/13 Money market rate in the baseline scenario MPR 2/13 Chart 1.16 Three−month money market rate in the baseline scenario1) and estimated forward rates.2) Percent. 2008 Q1 − 2016 Q4
1) Key policy rate in the baseline scenario plus premiums in the Norwegian money market. The calculations are based on the assumption that announced interest rate changes are priced into the money market.
2) Forward rates are based on money market rates and interest rate swaps. The blue and red bands show the highest and lowest forward rates in the period 31 May − 13 June 2013 and 25 February – 8 March 2013
Sources: Thomson Reuters and Norges Bank
2010 2011 2012 2013 2014 2015 2016
0 1 2 3 4 5 6
0 1 2 3 4 5 6
Key policy rate 3−month money market rate Lending rate, households
Chart 1.17 Projected key policy rate, three−month money market rate1) and interest rate on loans to households2) in the baseline scenario. Percent. 2010 Q1 − 2016 Q4
1) Key policy rate in the baseline scenario plus premiums in the Norwegian money market. The calculations are based on the announced interest rate changes are priced into the money market 2) Average interest rate on all loans to households from banks and mortage companies Sources: Statistics Norway and Norges Bank
Chart 1.19 shows there is a high probability that the key policy rate will be within the interval approved by the Executive Board in the period to 19 September. However, there is also some probability that the key policy rate will be set higher or lower than indicated by the interval. In autumn 2008, the Norwegian economy was exposed to major shocks as a consequence of the international financial crisis, and the key policy rate was set below the lower limit of the interval.
The projections in this Report imply that inflation will gradually pick up. With high inward labour migration and weak economic growth among Norway’s trading partners, wage growth may be lower than expected in the years ahead. In sectors supplying goods and services to households, cost inflation has been lower than in the economy as a whole in recent years. It cannot be ruled out that this trend may continue. There is also a risk of a further appreciation of the krone. Should the outlook for inflation, output or employment be substantially lower than projected, the key policy rate may be set lower than the forecast in this Report.
The key policy rate may also be increased more quickly than projected in this Report. In recent months, inflation has been somewhat higher than projected. The increase in inflation partly reflects temporary conditions. However, it cannot be ruled out that the recent pickup in inflation is a sign of higher underlying inflation than currently projected. At the same time, activity in the Norwegian economy may turn out to be higher than projected in this Report.
Cross-checks of the interest rate forecast
Simple monetary policy rules can prescribe interest rate setting that is robust to different assumptions about the functioning of the economy. The Taylor rule is based on projections for inflation, the output gap, money market premiums and the normal interest rate level. The Taylor rule calls for a key policy rate that is somewhat higher than the interest rate in the baseline scenario (see blue line in Chart 1.20). The growth rule, where the output gap is replaced by a growth gap, produces a key policy rate that is nearly identical with the interest rate forecast in this Report (see orange line). The light blue line shows
2004 2006 2008 2010 2012 2014 2016
80
85
90
95
100
105 −2
−1 0 1 2 3 4 5
I−44 (left−hand scale)
3−month rate differential (right−hand scale)
Chart 1.18 Three−month money market rate differential between Norway1) and trading partners and the import−weighted exchange rate index (I−44).2) January 2004 − December 2016
1) Key policy rate in the baseline scenario plus premiums in the Norwegian money market. The calculations are based on the assumption that announced interest rate changes are priced into the money market
2) A positive slope denotes a stronger krone exchange rate Sources: Thomson Reuters and Norges Bank
2008 2009 2010 2011 2012 2013 2014 2015 2016 0
1 2 3 4 5 6 7
0 1 2 3 4 5 6 7 30% 50% 70% 90%
Chart 1.19 Projected key policy rate in the baseline scenario and strategy interval with probability distribution. Percent. 2008 Q1 − 2016 Q4
Source: Norges Bank
2008 2009 2010 2011 2012 2013
0 1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8
Key policy rate in the baseline scenario Rule with external interest rates Growth rule
Model−robust interest rate rule Taylor rule
Chart 1.20 Key policy rate and calculations based on simple monetary policy rules.1) Percent. 2008 Q1 − 2013 Q3
1) The calculations are based on Norges Bank’s projections for the output gap, growth gap, consumer prices (CPIXE) and 3−month money market rates among trading partners. To ensure comparability with the key policy rate, the simple rules are adjusted for risk premiums in 3−month money market rates
Source: Norges Bank
a model-robust rule3 based on calculations in various models for the Norwegian economy. This rule gives greater weight to the output gap and inflation than the Taylor rule. It also gives weight to the interest rate in the previous period. The model-robust rule implies a key policy rate that is lower than the interest rate in the base- line scenario. A simple rule that gives considerable weight to changes in the interest rate differential against other countries also implies a lower interest rate than in the baseline scenario (see green line).
Forward money and bond market rates are another cross- check for the interest rate forecast. Estimated forward rates are somewhat higher than the money market fore- cast for the coming year (see Chart 1.16). Into the projec- tion period, the estimated forward rates suggest that market participants expect somewhat lower money market rates than projected in this Report.
Norges Bank’s previous interest rate setting can also serve as a cross-check for the interest rate in the baseline scenario. Chart 1.21 shows an estimated model that seeks in a simplified way to provide an explanation of histori- cal developments in the key policy rate based on inflation, wage growth, mainland GDP and interest rates abroad.
The interest rate in the previous period is also important.
The projections are based on the estimates for the under- lying variables in this Report. The uncertainty in this model is expressed by the blue band and the chart shows that the interest rate in the baseline scenario is in the upper part of this band.
3 For further analysis of this and other simple monetary policy rules, see Norges Bank Staff Memo 16/2012 and Norges Bank Staff Memo 17/2012.
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 0
1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8 90 percent confidence interval
Key policy rate in baseline scenario
Chart 1.21 Key policy rate and interest rate developments that follow from Norges Bank’s average pattern of interest rate setting.1) Percent. 2004 Q1 − 2013 Q3
1) Interest rate movements are explained by developments in inflation, mainland GDP growth, wage growth and 3−month money market rates among trading partners. The equation is estimated over the period 1999 Q1 – 2013 Q1. See Staff Memo 3/2008 for further discussion Source: Norges Bank
Criteria for an appropriate interest rate path
Over time, Norges Bank seeks to maintain inflation close to 2.5%. In its conduct of monetary policy, Norges Bank operates a flexible inflation targeting regime so that weight is given to both variability in inflation and variability in output and employment when setting the key policy rate.1 This flexible inflation targeting regime builds a bridge between the long-term objective of monetary policy, which is to anchor expectations of low and stable inflation, and the more short-term consideration of stabilising the economy.
Moreover, Norges Bank emphasises the importance of a robust monetary policy. The functioning of the economy is not fully known, and there may be uncertainty regarding the economic situation. In addi- tion, events will occur that are difficult to foresee.
Monetary policy also seeks to mitigate the risk of a build-up of financial imbalances. A prolonged rise in credit and asset prices increases the risk that finan- cial imbalances may trigger or amplify an economic downturn.
The following set of criteria can serve as a guideline for an appropriate interest rate path:
1. The inflation target is achieved:
The interest rate should be set with a view to stabilising inflation at target or bringing it back to target after a deviation has occurred.
2. The inflation targeting regime is flexible:
The interest rate path should provide a reasonable balance between the path for inflation and the path for overall capacity utilisation in the economy.
3. Monetary policy is robust:
The interest rate should be set so that monetary policy mitigates the risk of a build-up of financial imbalances, and so that acceptable developments in inflation and output are also likely under alternative assumptions about the functioning of the economy.
2008 2009 2010 2011 2012 2013 2014 2015 2016 0
1 2 3 4 5 6 7 8
0 1 2 3 4 5 6 7 8
Criterion 1 Criteria 1&2 Criteria 1,2&3
Chart 1.22a Key policy rate. Percent. 2008 Q1 − 2016 Q4
Source: Norges Bank
2008 2009 2010 2011 2012 2013 2014 2015 2016
−4
−3
−2
−1 0 1 2 3 4
−4
−3
−2
−1 0 1 2 3 4
Criterion 1 Criteria 1&2 Criteria 1,2&3
Chart 1.22b Output gap. Percent. 2008 Q1 − 2016 Q4
Source: Norges Bank
2008 2009 2010 2011 2012 2013 2014 2015 2016
−1 0 1 2 3 4 5
−1 0 1 2 3 4 5
Criterion 1 Criteria 1&2 Criteria 1,2&3
Chart 1.22c CPI−ATE.1) Four−quarter change. Percent. 2008 Q1 − 2016 Q4
1) CPI adjusted for tax changes and excluding energy products Sources: Statistics Norway and Norges Bank
The various considerations expressed in the criteria must be weighed against each other. The first two criteria reflect the flexible inflation targeting regime.
The consideration of robustness is not an objective in itself, but is included because in an uncertain world taking robustness into consideration may bring about a more stable attainment of inflation, output and employment targets over time.
Charts 1.22 a-c illustrate the forecasts for the key policy rate, output gap and inflation when the various criteria are taken into account.
If monetary policy gave weight only to the current low level of inflation, the key policy rate would, ac- cording to a technical model-based analysis, be low- ered sharply and kept near zero for some time, (see red lines in the charts).2 Inflation might then pick up fairly quickly, partly owing to a weaker krone, but output and employment might then show substantial fluctuations.
When weight is also given to avoiding excessive fluctuations in output and employment, the key policy rate will, according to a technical model-based analysis, be somewhat higher in the coming years (see blue line).3 Inflation will then take somewhat longer to rise towards 2.5%, but developments in output and employment will be more stable.
Monetary policy also seeks to be robust and to mitigate the risk of a build-up in the economy of financial imbalances. This consideration is now pushing up the interest rate path. In the baseline scenario (see black line), the key policy rate is there- fore higher than implied by a technical model-based analysis that does not take robustness into
consideration. In the baseline scenario, output and employment are projected to move on a more stable path, while it takes longer for inflation to move up towards target.
1 The trade-offs between price stability and stability in the real economy is often expressed in the literature as a loss function, which takes into account variability in output and variability in inflation:
Lt = (πt – π*)2+ λ(yt – y*t)2
where Lt is the loss, (πt – π*) is the deviation between actual inflation and the inflation target and (yt – y*t) is the output gap. How much weight is given to stable developments in output/employment relative to inflation is determined by the parameter λ.
2 In this model analysis, we have used our macroeconomic model NEMO, using a loss function that only gives weight to inflation.
3 In this model analysis, we have used NEMO with a loss function that gives weight to both inflation and the output gap, where the weight of the output gap is set at 0.5.
Flexible inflation targeting
Monetary policy is oriented towards low and stable inflation. The operational target of monetary policy is annual consumer price inflation of approximately 2.5% over time. At the same time, monetary policy shall contribute to stable developments in output and employment. Thus, the inflation targeting regime is flexible.
The inflation target for monetary policy was intro- duced in 2001. Since then, developments in consumer prices have been well within the range of flexibility provided in the mandate for monetary policy. While the 12-month rise in the CPI has been 1.8% on average, annual inflation has varied between 0.4% and 3.8%. Consumer price inflation can, to some extent, vary from month to month and from year to year as a consequence of more random fluctuations in certain prices, including energy prices.
Measured as a two-year moving average, annual inflation has varied between 1% and 3%. Inflation has been low and stable.
Monetary policy is flexible and in interest rate setting Norges Bank can give weight to factors other than price inflation as long as inflation expectations remain low and stable. When inflation is high, the key policy rate will thus be set with a view to bringing down inflation and preventing inflation expectations from becoming unanchored. Expectations of high inflation may become self-reinforcing, driving up inflation even further. At the same time, high inflation tends to lead to wider variability in inflation, which makes
it more difficult for households and businesses to plan. Moreover, experience shows that there are considerable costs associated with bringing inflation down from high levels.
Conversely, when inflation is low, the key policy rate will be set with a view to bringing up inflation and to preventing inflation expectations from becoming entrenched at too low a level. Inflation expectations that are too low may weaken the effectiveness of
monetary policy. When inflation or output has become too low following an economic downturn, real interest rates should be reduced to counteract these developments. There are limits to how low the key policy rate can be set. If inflationary expectations are very low, this will limit the scope for decline in the real interest rate. This may have a self-reinforcing effect and pull inflation further down. The extreme outcome may be a deflationary recession, with high costs to the economy in general and to borrowers in particular.
Interest rate setting, inflation and the wider economy will be affected by the shocks to which the economy is exposed. Norges Bank will to a further extent than otherwise accept high inflation if both the current situation and outlook for production and employment in Norway are weak. likewise, Norges Bank will to a further extent than otherwise accept low inflation if both the current situation and the outlook for production and employment in Norway are favour- able. Norges Bank also gives weight to robustness and takes account of the risk of a build-up of financial imbalances. These considerations will also affect how quickly inflation is brought back to target.
Inflation is currently low, but is projected in this Report to rise gradually to 1¾% by end-2016.
Inflation is low partly owing to low external price impulses and a strong krone. The krone is strong partly because oil prices are high and because interest rates abroad are close to zero. At the same time, the crisis in Europe is having a dampening effect on wage growth in Norway. Thus, there are powerful external forces that are holding down price and cost inflation. This also means that the key policy rate must be set very low to fully counteract these forces. In a situation where debt and house prices continue to rise, and with capacity utilisation in the Norwegian economy close to a normal level, allowing time to bring inflation back to target will be a reason- able course of action.
